Employees’ Provident Fund (EPF or PF) is one of the few retirement savings schemes available to the organized sector with significant tax benefits and sovereign-backed returns, which are generally higher than most other fixed-income products. Tax exemption is available on accruals as well as withdrawals, on contributions made (this triple taxation benefit is known as EEE or Exempt, Exempt, Exemption Scheme).
With an aim to limit the tax benefits on PF to members making higher contributions generally through Voluntary Provident Fund (VPF), taxation of interest earned on employees’ contributions was introduced in Budget 2021. 2.5 lakh per financial year with effect from FY 2021-22. This applies only to the contribution made by the employee and not the employer.
For cases where the employer does not contribute to the PF of the employee, the limit beyond which the interest will be taxable 5 lakhs.
practical aspects to be considered
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The Central Board of Direct Taxes (CBDT) had issued a notification last year detailing how it would work. The employee’s contribution will be divided into two accounts holding taxable and non-taxable funds. Taxable fund will include employee contribution in excess of 2.5 lakh effective FY 2021-22 and the related interest less any withdrawal.
Credit of taxable interest withholds tax obligations in respect of non-exempt establishments. Employees’ Provident Fund Organization (EPFO) will be responsible for this. However, organizations having PF trust will have to gear up to segregate the corpus and meet the tax withholding obligations. limit of 2.5 lakh is as of the financial year effective FY 2021-22, and will also include voluntary contributions. The interest earned on such contribution shall be taxable as “income from other sources” and shall form part of the taxable fund.
Interest escalation will also be taxable in case the member’s continuous service with the employer is more than 5 years.
Taxpayers have the option of taxing “income from other sources” on accrual basis or on cash basis. Accordingly, taxpayers will be required to claim taxes withheld in the respective tax years in which income tax is offered.
Advance tax liabilities need to be taken into account. Employees also have the option to declare their personal income to the employer so as to adequately cover the tax obligations on such income.
harm should be avoided
It is important to understand the financial implications of taxability of interest before deciding to reduce PF contribution.
One reaction of many employees may be to treat PF contribution as unattractive from tax point of view and limit the contribution to the statutory salary limit. 15,000. This would mean that employee contributions are limited. 1,800 per month.
It is important to remember that employer contributions to PF are eligible for tax exemption (even under simple tax regime) and employee contributions are eligible for deduction under section 80C under regular tax regime.
The table provides a comparative financial impact analysis where an employee decides to limit the PF contribution to the statutory salary limit and chooses to pay taxes under the regular tax regime.
There are issues such as the approach to be adopted when an employee avails a loan—whether to be adjusted from the taxable or non-taxable corpus, whether the actual interest rate differs from the estimated at the end of the year until withholding. is, etc.
At present, the rules do not cover these aspects, except for the fact that two separate accounts would be required to be maintained. EPFO/CBDT may need to come up with further guidelines which could potentially provide clarifications on these issues.
Saraswati Kasturirangan is a partner of Deloitte India. Prashant G, manager of Deloitte Haskins & Sales LLP, contributed to the column.
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